TAX-REFORM PROPOSALS MAY HURT INVESTMENTS

With flat-tax proposals gaining momentum on Capitol Hill, investors and homeowners may want to take some precautions just in case a major tax overhaul does come about.

The tax-reform proposals that have been put forth by congressional leaders in recent weeks would likely have a significant effect on property values, the out-of-pocket cost of owning a home, and the relative merits of various investments.

A flat tax would vastly simplify the income tax system by eliminating most deductions and imposing lower rates on taxpayers' income. For example, House Majority Leader Dick Armey is pushing a plan that would tax income at a 17 percent rate and abolish all deductions, including those for mortgage interest and property taxes. House Democratic Leader Richard Gephardt recently announced he is putting together an alternative plan that would impose a 10 percent or 11 percent tax rate for most families, with higher rates for upper-income families. And House Ways and Means Committee Chairman Bill Archer, R-Texas, wants to replace the income tax with one on consumption, such as a national sales tax.

The political prospects for a major overhaul of the tax system are uncertain. But the fact that these proposals are being pushed by leading lawmakers on both sides of the political aisle makes the possibility something that individuals should take into account when making long-term financial decisions.

Any move to a new tax system would likely be phased in over a period of years with some protections built in for existing investments, said Stephen Corrick, a Washington, D.C., tax partner at the accounting firm of Arthur Andersen & Co. "They are going to have to have a fairly liberal transition phase," he said.

Even if that happened, some existing investments could still be hurt.

For example, if the tax system no longer allowed deductions for mortgage interest and property taxes there would likely be downward pressure on property values, because the out-of-pocket cost of monthly house payments would go up.

How much? Say you're now in the 28 percent tax bracket and your monthly mortgage interest and property taxes run $1,000. What you're now paying out-of-pocket - after the tax-savings from the mortgage and property tax deductions - is $720 a month. If these deductions were completely eliminated, your out-of-pocket cost would be $1,000 a month, an increase of $280, or 38 percent.

You probably wouldn't have to look far for the extra $280 a month because your income would be taxed at a lower rate under the flat tax. Nevertheless, the relative cost of housing would go up as a proportion of your after-tax income. And studies have found that people are sensitive to what percentage of their income goes toward housing.

Even if the deductions of existing homeowners were somehow "grandfathered," potential buyers probably wouldn't be willing to pay as much for your home as they would now with the existing tax benefits.

How can you protect yourself?

-- DON'T COUNT ON FULL IMMUNITY: Even if lawmakers "grandfathered" existing mortgages, the deductions would be worth less if tax rates were lowered. What's more, you should consider the possibility that Congress might provide only limited protection. Congress didn't grandfather outstanding consumer loans when it phased-out the personal interest deduction over a four-year period under the Tax Reform Act of 1986.

-- DIVERSIFY: Diversifying your investments is critical, particularly if you have tax-advantaged investments in your portfolio. For example, the tax-exemption for state and local municipal bonds would become less valuable if tax rates were lowered, and the market-value of outstanding bonds could decline as a result.

Such tax-favored investments could even lose their advantage over taxable investments if a consumption tax replaced the income tax. To minimize the risk that the market value of tax-exempt securities could be hurt by tax reform, one option is to stick to shorter-term maturities. Another option is to match maturities to the time you'll need the money so you'll be assured of receiving full par value when you cash them in.

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CALENDAR WATCH: Employees who claimed exemption from income tax withholding on the W-4 form they filed last year with their employer must file a new W-4 by Feb. 15 to continue their exemption for another year.

Qualifying for an exemption isn't easy. Eligible are employees who had no tax liability last year and expect to have no tax liability this year.

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BUSINESS TRAVEL: Business travelers who are upset that their employer no longer allows them to fly first-class are in good company.

Employers have been relegating more and more of their employees to the coach section.

Only about 8 percent of business travelers were allowed to fly first or business class last year, according to a new survey of 345 corporate travel managers by the Runzheimer International consulting firm. That compares with 11 percent in 1992 and 28 percent in 1984.

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Gary Klott is a former reporter for the Sun-Sentinel and The New York Times. His column appears on Sundays.